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Decumulation Roadblock Removal


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Retirement is a new and potentially long chapter of your life.   As 401(k) plans have evolved from a supplemental retirement or capital accumulation plan to the sole retirement vehicle offered by most plan sponsors, sponsors and participants alike are increasingly focused on the decumulation phase—practically speaking, how to make the money last a lifetime.

That means ensuring that this income has the potential to last for your lifetime and to weather rising health care expenses, inflation, and market ups and downs.  First and foremost, you’ll want to make sure your day-to-day expenses are covered and that your income and assets will last for what could be a 30-year—or longer—retirement period.  There are many roadblocks to accomplishing that goal.

Federal Reserve Roadblock.  Retirees and their nest eggs have been hammered by the Fed’s policy. The Fed has said that low rates help the economic recovery. So it argues, in effect, that investors should enjoy the solid stock market returns and that savers should display a stiff upper lip.

Beyond savings and CD rates, the Federal Reserve’s policy is changing fundamentals of key senior financial products.  There is little new to say about the way non-existent interest rates on savings accounts, certificates of deposit, and U.S. Treasury securities have hurt all savers, particularly risk-averse investors.

Market Volatility Roadblock.  The impact of bad markets on a portfolio while you’re saving and investing during your working years may slow down your plans and delay your future retirement date.  Many investors feel that the stock market remains the most attractive place for investors over the long term – beating out bonds and other low-risk investments. However, to earn those higher returns, investors face more volatility.

After you enter retirement, down markets can be devastating, because your ability to recover is limited.  Many older investors simply don’t have enough time before retirement to risk a big loss. Even investors who are confident they can earn superior returns from stocks may reach a point where they want to lock in some of their gains in case markets turn fickle.

Many retirees learned the hard way that it’s dangerous to rely on outcomes that are merely a “best estimate” of the future. Instead, they need to rely on “scenario planning,” where you see if you can survive worst-case possibilities. It also helps to see what might happen if the future turns out to be better than your best estimate.

It might be smart to get some income from annuities that protect you if economic conditions are unfavorable and then other sources of income in the market that would do well if economic conditions turn out better than expected. Guaranteed products — annuities — provide higher retirement income under unfavorable conditions than products that rely on investing retirement assets.

Why do we suggest including a fixed-income annuity as part of a diversified income strategy? It’s straightforward: Fixed annuities, along with Social Security and/or pensions, provide guaranteed income to help meet essential expenses.  In many respects, Social Security payments are like an annuity, although one that has very attractive cost-of-living increases.

A lot of folks would like to have more retirement income that is that safe.  Often, one spouse wants to make sure that annuity payments continue for his life and, should he die, for the remaining life of his spouse as well. Lots of annuity contracts include that provision.

How can you achieve higher interest earnings without putting your hard-earned principal at risk? With a product that offers a minimum rate of return, ties its interest earnings to a stock market index and guarantees that the principal deposit and any interest earnings credited will always be protected – an equity indexed annuity, also called a fixed indexed annuity.

Fixed Indexed Annuities are tied to major stock market indexes and not to the performance of individual stocks or mutual funds, providing complete safety of principal.  Fixed index annuities allow you to share in stock market gains without risking your principal when the stock market takes a downturn.

Since annuities are based on external indexes like the S&P 500, when the markets go up you have the opportunity to share in gains.  If the stock market falls, your contract value will not decrease. Not only is there “zero market-risk” associated with fixed indexed annuities, but when the market goes up and you have a gain in your account, it is locked-in each year and yours to keep! It cannot be taken away, you cannot lose your gain.

What’s more important is that you now have the protection of lifetime income to ensure that your essential expenses are covered throughout retirement. Even in a 0% return market, although their investment portfolio may run out of money, their annuities continue to pay income for their lifetime

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Monday, August 18th, 2014 Wealth Management Comments Off

Retirement Zig and Zag Jigsaw Puzzle

Many people, especially retirees are desperate for something that will protect their portfolios the next time stocks sink.  An investment that will generate decent long-term returns – but also post gains when stocks are suffering.  The term “retirement plan” for a 401K, a 403B, a 527, can mistakenly lead to the belief that you actually have a plan for retirement.

The purpose of a retirement income plan is to put together the jigsaw puzzle of your available resources, your needs and the financial industry’s products and services so as to maximize your income and minimize your risk.  One key lesson: Use a highly diversified approach. This minimizes volatility in your income amid stock-market zigs and zags.

In retirement, variability becomes a problem because you’re drawing down your portfolio at the same time as you’re experiencing market volatility. During this stage of your life, the sequence of returns you encounter can have a big effect on how long your portfolio will survive. Someone who gets hit by early losses, but has to keep withdrawing funds, may run out of money

At various times during your retirement, you will, in all likelihood, witness some sharp drops in the market.  It’s probably natural to get somewhat more apprehensive about market volatility during your retirement years making it harder to navigate the sometimes-choppy waters of the financial world.

As an investor, you’re well aware that the financial markets always move up and down.  But what happens when you retire and you are more susceptible to market movements?  One important point is to build in a margin of safety. Rather than planning for a 20-year retirement, prepare for 30 years of life after work.  Of course, the longer you expect to live, the more money it takes.

Given our growing awareness of healthier lifestyles, you could easily spend two, or even three, decades in retirement.  Statistics tells us that a man who reaches 65 can expect to live another 18.5 years, while a woman at that age can look forward to another 21.6 years. But those, too, are just averages.

A substantial number will live far longer; that’s what an average implies. To account for the very real possibility that you will still be chugging away well into your 90s, a well thought-out financial plan should prepare you for at least 30 years of retirement – much longer than the averages would initially suggest.  You may want to be particularly vigilant about taking steps to help smooth out the effects of market volatility.

Everyone is different. While the “average” retiree may be invested appropriately from a risk perspective, considerable differences exist among retirees. Some of us are good at real estate investing. Some of us have the right temperament to invest in the stock market. Some of us are good at building a business.  The optimal level of risk is going to vary by retiree.

The appropriate level of risk for a retiree is going to vary depending on an individual’s circumstances. Many people try to “time” the market. You may be tempted to “take advantage” of volatility by looking for opportunities to “buy low and sell high.” In theory, this is a fine idea — but, unfortunately, no one can really predict market highs or lows.

Risk tolerance has to with someone’s general preference for risk and feelings about volatility. Spreading your money among a range of vehicles — stocks, bonds, certificates of deposit, government securities and so on —can help you avoid taking the full brunt of a downturn that may primarily hit just one type of investment.

The most daunting risk facing retirees is the uncertainty regarding the length of life they will need to fund. Fortunately, with ordinary fixed annuities, you can provide level income for your maximum lifespan for about 40% less than it would take to provide the same level of lifetime income security using noninsurance vehicles.

We need to hedge against our personal cost of living. Many retiree investors in the past few years have discovered a different strategy for a portion of their portfolio that retains the fixed income nature of bonds while offering protection from equity market declines. It’s called fixed-index annuities, or “FIAs.”

FIA’s offer several distinct advantages, including protection from market declines, elimination of bond default risk, participation in positive performance of stock market indexes, tax deferral in non-retirement accounts, sustainable lifetime income with a MGWB or income rider, investment management simplification, and elimination of investment management fees on the portion of a managed portfolio that’s invested in FIA’s.

A fixed-indexed annuity, or FIA for short, is an annuity that earns interest that is linked to a stock or other equity index. One of the most commonly used indices is the Standard & Poor’s 500 Composite Stock Price Index (the S&P 500).

With concerns over inflation and making sure that investments will meet our future needs, many people have turned to the fixed market for higher returns. It makes sense when you consider how well the S&P 500 index has performed historically.

The first and possibly most attractive provision of a fixed-indexed annuity is the no-loss provision. This means that once a premium payment has been made or interest has been credited to the account, the account value will never decrease below that amount. This provides safety against the volatility of the S&P 500.

FIAs offer consumers what could be described as the best of both worlds: a market-driven investment with potentially attractive returns, plus a guaranteed minimum return. In short: You get less upside but much less downside.

While it’s a lot like investing directly in the stock market, you don’t get the full boost of a rising market. With fixed-indexed annuities, the money put down by you, as a purchaser, isn’t invested directly in the stock market. Instead, you are offered a percentage of how much the index gains over a period of time, and a guaranteed minimum return if the stock market declines.

Your fixed-indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum.

Most policies have a cap (the maximum interest rate that can be credited to a policy in a policy year) and a floor (the minimum interest rate that can be credited in a policy year). The cap rate can vary from no cap to a fixed percentage, but the floor is generally zero. This allows the policyholder to benefit from potentially high returns and be guaranteed at the same time that no money will be lost.

Before you invest in an fixed-indexed annuity you will want to read the fine print. There are surrender charges for early withdrawal, although most companies now allow yearly withdrawals at set amounts. Notably, the surrender charges often decrease the longer you let the company keep your money.

Given their advantages, fixed-index annuities purchased from highly-rated insurance carriers may provide a suitable alternative for a portion of a portfolio for investors who are desperate for something that will protect their portfolios the next time stocks sink.  An investment that will generate decent long-term returns – but also post gains when stocks are suffering.

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Sunday, August 17th, 2014 Wealth Preservation Comments Off

Worry-Free, Sufficient, Steady Cash Inflow

One of the biggest fears most retirees have is outliving their money. There’s no doubt post-retirement poverty is highest among the very old, and that this group also faces high costs for medical care. Not a lot of fun to think about.

We all know the statistics: An estimated 10,000 boomers retire every day. They’re living longer than ever. For a couple aged 65 today, there’s a 25% chance one of them will live to be 97, according to the Society of Actuaries. With people living into their ninth and tenth decades, this is something to be worried about.

We must be vigilant of the minefields that threaten our retirements. With bond yields bumping up against generational lows, it’s difficult to believe that fixed-income investments will provide anywhere near the same returns they did over the past three decades.

For retirees and for near-retirees, that poses an enormous challenge.  The obvious alternative would be to load up on stocks – but that poses risks of its own. If you happen to retire just as the market tanks, you could wipe out a big portion of your savings.

Individuals who lie awake at night worrying about market volatility and wondering if they will have enough to cover their living expenses might want to think about the stocks-and-annuity approach.

The best combinations of assets for investors who want to draw a steady, inflation-adjusted income equal to 4 per cent a year of their initial portfolio. We have found the most effective combinations tended to be blends of annuities and stocks, or even an all-annuity portfolio.

The beauty of this strategy is that it reduces the biggest risk to retirement portfolios – the possibility that a stock market crash early in your retirement will gut your portfolio.

Which mix is best for you?  Suggests you begin by looking at your essential expenses and calculating how much of your portfolio you would have to convert into annuities to cover those unavoidable costs. The remainder of your portfolio could then be directed into stocks.  A retiree can annuitize just that portion of wealth necessary to pay monthly living and heath expenses, leaving the rest of his or her assets for emergencies and (some day) bequests

Annuities protect against the risk that a retiree will live so long he’ll outlive his savings–known as “longevity risk.” With annuities, the risk you’re insuring against isn’t just living too long, but being impoverished if you do live too long. Once a retiree buys an annuity, all he has to do is sit back and cash checks for the rest of his life.

Married couples can purchase annuities that will continue to pay until the last one of the pair dies. A $100,000 up-front payment will buy a 65-year-old man and his 65-year-old wife a $537 monthly check that either one can keep cashing for as long as they live.

A 65-year-old man buying on his own would get a $640 monthly check; a 65-year-old woman, $590. The haircut for couples sounds like a lot, but it’s actually fair, given the greater chance that at least one of the two will make it past 90 (greater, that is, than the chance either has on his own.)

Typically, we need worry-free, sufficient, steady cash inflow, most of it insulated from wide marketplace price fluctuations, free from daily micro-management burdens and, preferably, tax-favored.

In a typical year, the stock market will return as much as many annuities do and leave your heirs with the principal when you die. The problem with gambling on stocks, as older folks are now learning, is that if your retirement coincides with a bear market, you can wind up broke.

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Monday, August 11th, 2014 Wealth Management, Wealth Preservation Comments Off

The Right Tool For Retirement

Even though the stock market has improved, some investors are still gun shy.  Investors nearing retirement learned about market volatility the hard way, leading to lower risk tolerance.  Due to increased life expectancies, most baby boomers will live longer and this means they need more money for more time

Retirement accounts got hit hard by market events like the dot-com bust, the housing meltdown and the subsequent financial crisis. Some people stopped investing entirely because they were afraid to put their life savings at risk.  But at the same time, savings accounts and certificates of deposit aren’t even beating inflation. They’re just not the right tools with which to build a healthy retirement.

Realizing that their savings aren’t enough often prompts people to take far too much risk with their money at a time when they should be investing more conservatively.  Those who can delay gratification have the ability to control their emotions and impulses and usually end up more successful.

Conventional wisdom says the more you know about personal finance, the better off you’ll be at managing your money. When smaller investors jumped in with both feet, like they have in recent months, it should be a red flag to everyone else because almost always smaller investors buy at the top and sell at the bottom.

Smaller investors make a rationale that they will plan to go to cash after they get back to where they were before the declines began. Instead of just selling, they decide to wait for a bounce, and after the market tops, bounces never come. This is the error that caused wealth destruction for so many in 2008.

Your reaction to the Dow or the S&P 500 maybe extreme exuberance if the Dow is up 100 points, our economic spirits are lifted, conversely, if the Dow is down 2 percent, we despair.  Yet those indices probably have nothing to do with our retirement or other long term goals.  How do they work?

The Dow Jones Industrial Average includes only 30 large company stocks and represents about one-quarter of the value of the entire U.S. stock market. Furthermore, the DJIA is price-weighted. This means a $1 change in the price of a $188 stock in the index will have the same effect as a $1 change in a $20 stock, even though one may have actually changed 0.2% and the other by 5%.

The S&P 500 , of course, tracks 500 major U.S. companies. These have been chosen to include a range of industry sectors and represents about 70% of the total value of the U.S. stock market. Yet its focus on large companies means it’s not representative of the entire market, smaller stocks in particular. Furthermore, the S&P is market-weighted. If the total market value of all 500 companies falls 10%, the value of the index falls 10%. A 10% movement in all 30 stocks of the DJIA would not cause a 10% change in that index.

The Russell 2000 (IWM) tracks smaller U.S. companies. Note that it’s market value-weighted (on market cap) of 2,000 of the smallest stocks. In other words, it tracks the largest of the small.

Indices, on the other hand, have no frictional expenses because they are an imaginary group of stocks held in a cost-free portfolio. Therefore, even if your portfolio were an exact match of an index’s underlying holdings, it would be hard to outperform them.

The Dow gave investors an early July gift as the market closed above the 17,000-point barrier for the first time, and the S&P rose 10 points, and the Nasdaq rose 28 points.  Yet, the S&P 500 tumbled 2.7 percent last week, the most since June 2012.  Indexes of U.S. and global equities fell in July, halting a five-month streak of gains.

Stocks today are expensive and if the Federal Reserve begins raising interest rates next year and the market runs into problems, the popping sound you may hear is the sound of the Fed popping bubbles.  Just as the Fed was monkeying with interest rates that helped fuel the mid-2000’s housing bubble, which led to the 2008 financial crisis and the great recession, once again we have standing on the verge of prosperity, but like before most likely we will see our opportunities fizzle.

We’ve reached a point where the U.S. market is in a sit-and-wait mode, and the economic figures will eventually bring back the question of when the Federal Reserve will hike rates. Now concern has grown that the Fed is going to raise interest rates sooner than expected.  This challenges the notion that a rising tide automatically will lift all boats: “A lifeboat carrying a few, surrounded by many treading water, risks capsizing.  Analysts note hopefully that the current resurgence is built on foundations sturdier than the ups and downs of the stock market.

There is a broader issue here in terms of being driven by indices instead of what’s really important thing about retirement.  Nothing boosts retirement confidence like an annuity.  The most important goal of retirees is wanting to have enough money to last their entire lifetime.  Stocks and bonds are the traditional investments for growth and security, but near retirees and retirees fear a big drop in the stock market at the time of retirement could decimate their savings.

Annuities provide growth and security for retirement income.  Longevity insurance was recently blessed again by the IRS with its finalization of a regulation allowing the inclusion of an advanced-age lifetime-income option in retirement plans such as 401(k) plans and IRAs.

Thanks to the QLAC ruling on July 1, the annuity sales game has been changed forever, and in the consumer’s favor. On July 1 of this year, the Department of the Treasury and the IRS approved the use of Qualified Longevity Annuity Contracts, aka QLACs, within 401(k)s and IRAs. QLACs are also known as Longevity Annuities or Deferred Income Annuities (DIAs) and were introduced around 10 years ago as a simplistic, no-fee way to solve for lifetime income starting at a future date.

Consumers will be forced to educate themselves about annuity lifetime income strategies, and the true transfer of risk value proposition that the category offers.  In addition, once people figure out the simple and efficient nature of the longevity annuity strategy, they will be more apt to add a longevity annuity to their non-IRA accounts as well just based on familiarity.

Qualified Longevity Annuity Contracts will also educate current workers with 401(k)s how annuities can work on their portfolio and compliment future Social Security payments. With the longevity annuity strategy, only the contractual reality exists. There is no way for an agent to juice the numbers on a longevity annuity proposal. It’s a commodity product.

In a nutshell, IRS’ final regulation allows you to invest up to the lesser of $125,000 or 25% of your retirement plan balance in “qualifying longevity annuity contracts” (QLACs) provided that lifetime distributions begin at a specified date no later than age 85. Although the regulation leaves the door open for other types of fixed income annuities in the future, QLAC investment vehicles are currently limited to lifetime deferred income annuities, or DIAs.

Suppose you’re concerned about the possibility of outliving your assets and you’re considering investing a portion of your retirement plan in a QLAC. Do you have to wait until age 85 to begin receiving your lifetime annuity payments? Absolutely not. So long as distributions begin no later than the first day of the month following the attainment of age 85, you will be in compliance with the regulation.

As you can see, there’s a lot of flexibility when it comes to selecting the start date of your lifetime income distributions from a QLAC. There’s approximately a 13- to 14-year window depending upon your birth date which falls between April 2 of the year following the year that you turn 70-1/2 and age 85. The key is that you must define your income start date at the time of applying for your QLAC. This is a requirement of all deferred income annuities, not just QLAC’s.

It is said that people don’t know what they want until you show it to them, and my prediction is that the QLAC ruling will be the annuity industry’s turning point back to simplicity once people see how simple and efficient a longevity annuity really is.

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Wednesday, August 6th, 2014 Wealth Management Comments Off

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